Even the wackiest-looking wind farm can seem intriguing when oil is selling for more than $70 per barrel. Soaring petroleum prices and a host of other factors are narrowing the gap between the cost of traditional and alternative energy sources, such as solar panels, wind generators and biodiesel fuels.
Environmental mandates to reduce carbon-based emissions are boosting demand, as are government tax credits that reduce the cost of new power sources. The European Union’s stated goal is that 20 to 25 percent of the region’s energy demands be met through alternative sources by 2010; the current figures across the continent range from 5 percent to 15 percent. With stronger demand comes improved economies of scale, sparking more advanced, and less costly, technologies.
Tracking 86 stocks listed in 18 markets around the globe, the WilderHill new energy global innovation index, or NEX — total market capitalization: $276 billion — offers a comprehensive overview of the soaring value of alternative energy shares. Leading industries in the index: solar, wind and biomass.
In the 12 months through June 15, the NEX was up 28.7 percent, more than doubling the MSCI world index’s 11.3 percent gain. Over three years the NEX index returned an annualized 27.2 percent, topping the global market by nearly 13 percentage points annually. Over the past five years, alternative energy shares returned 8.9 percent annually on average, compared with 4.9 percent for the MSCI world index. (Alternative energy shares got hammered in 2001 and ’02, as did traditional energy stocks.)
Shares in alternative energy companies don’t come cheap, even by growth-stock standards. Of the index’s 86 stocks, only 53 are reporting earnings, and their average trailing price-earnings ratio through the end of May was 57.6, versus a 16.7 multiple for the MSCI world index. The shares are also richly valued on a price-to-book basis. With 83 reporting positive book values, their average price-book is 4.61; for the MSCI world index, it is 2.52.
And many are lightly traded stocks. For some, average daily trading volume runs about 300,000 shares. A spike in trading caused by company news or an energy-related event could increase volatility, causing spreads to significantly widen. Cautions James Atkinson, co-principal of London-based Guinness Atkinson Asset Management, which recently launched the Alternative Energy Fund: “A large percentage of the investable universe is made up of thinly traded small-cap stocks, many of which are losing money or just beginning to produce profits. Their fortunes are strongly correlated to rising oil prices.”
Atkinson believes, nonetheless, that fundamental shifts in energy economics are lining up squarely behind alternatives. “The price gap between traditional and alternative energy sources is being compressed by environmental mandates to reduce carbon emissions, government tax credits that are reducing the kilowatt-hour costs of new power sources and demand that is creating a virtuous cycle that’s improving economies of scale.”
Identifying future market leaders will be tricky, notes Credit Suisse energy analyst William Young. “It’s early for portfolio managers to pick the long-term winners,” he says. “So the strategy appears to be based on the assumption that if two or three out of ten stocks are successful, the gains will significantly outweigh the losses on those that do not survive.”
Merrill Lynch & Co.’s Luxembourg-based, $2.6 billion New Energy Fund ranks as the biggest alternative energy portfolio. Launched in April 2001 with $5 million, it survived an ugly 2002. That year energy prices went nowhere, and the sector did even worse than the overall equity markets: The Standard & Poor’s 500 index fell 22.1 percent, while the S&P global energy sector index was off about 7 percent and the Merrill fund plummeted 56 percent. For the 12 months ended this June 14, the fund, whose assets are spread across 75 stocks, rose by 31.2 percent, with three-year annualized returns of 29.8 percent. As a result of the 2002 meltdown, though, the fund is down an annualized 12.8 percent since inception.
One of its major holdings is Carpenteria, California–based Clipper Windpower, a wind turbine manufacturer that went public on the London Stock Exchange Alternative Investment Market in September 2005. New Energy Fund co-managers Robin Batchelor and Poppy Buxton purchased shares at the company’s IPO at £1.90 ($3.46). By April the stock was trading at £4.05.
Batchelor likes Clipper for several reasons. First, its location provides direct access to the U.S., the world’s fastest-growing wind market, which gives Clipper a significant cost advantage over foreign competitors that are hampered by transportation costs and price pressures owing to the falling dollar. Second, the start-up is the second go-round for the management team that ran ZOND, a privately financed wind turbine venture that has become General Electric Co.’s primary wind unit. And third, government tax credits subsidize approximately one third of the cost of wind production, boosting demand for infrastructure and leading to a shortage in turbines, which gives manufacturers better pricing power.
Sustainable Asset Management’s Smart Energy Fund, based in Luxembourg, looks for well-established companies with proven technologies. Fund manager Dieter Küffer invests 36.7 percent in renewable energy; 31.9 percent in companies that sell technologies that enhance efficiencies; 19.9 percent in natural-gas companies, which he expects will benefit from continued market liberalization, especially across Europe; 7.3 percent in energy distribution; and 4.2 percent in ancillary services.
Says Küffer: “We see several trends giving worldwide energy markets a new focus. These include increasing environmental awareness, especially involving climate change, growing demand for energy in emerging markets and liberalization of power markets.”
Smart Energy debuted in September 2003, fortuitously missing the previous year’s downturn, and is up 40 percent since then. But after the market’s May sell-off, the fund was up only 11.9 percent for the 12 months ended June 14.
Küffer’s investment in Conergy, Germany’s largest manufacturer and distributor of solar panels, reflects his desire to own stock in established businesses. With a 50 percent share of the German solar market and with subsidiaries in Australia, France and the U.S., the company is diversifying revenue flow into wind power and bioenergy. Conergy expects its revenues from these nonsolar sources to increase from 3 percent in 2004 to 20 percent in 2006. And it expects its foreign sales to reach 25 percent of revenues this year, up from 6.7 percent in 2004.
The company, which has a market cap of E1.7 billion ($2.1 billion), moved from a E1 million loss in 2002 to a E28 million profit in 2005, with earnings expected to rise to E42 million in 2006. During the same period, operating margins shifted from negative to an estimated 8 percent this year.
The engine of growth: the German Renewable Energy Act, enacted in 2001, which guarantees households that contribute solar energy to the country’s electrical grid E0.60 per kilowatt hour for the next 20 years. Küffer estimates that production costs are E0.35. Consequently, this program is fueling strong demand for solar panels across Germany. That demand is improving economies of scale while sustaining pricing power for manufacturers. The result: improved margins and profits.
Küffer established his initial E700,000 position at a share price of E102 in January. He quickly added to his stake, keeping his average cost at E102.7. By April 19, Conergy shares were trading at E172, boosting the value of his holding to E1.6 million.
For a U.S.-based alternative energy play, PowerShares Wilderhill Clean Energy ETF offers exposure to 40 domestically listed stocks, including several American depositary receipts. Its top three sectors — power delivery and conservation, renewable energy harvesting and energy conversion — make up more than 70 percent of the fund’s assets.
Robert Wilder, whose Ph.D. focused on environmental policy, is the CEO of Wilderhill and manager of the fund. Instead of using traditional financial metrics, Wilder picks companies based on technological innovation, patents pending and contribution to energy efficiency.
Since its March 2005 IPO at $15.50, the ETF has risen 23 percent, to $19.10, as of June 15. More dramatically, the asset base has soared from $10 million to more than $737 million.
Argues Wilder: “When investors see what’s happening to the price of traditional fuels; are aware of the environmental impacts of a heavily hydrocarbon- dependent economy; and hear the president emphasize the need for supporting alternative energy sources, the case for alternative energy becomes more compelling and a lot easier to understand.”
